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Accounting for Entrepreneurship: A Knowledge-Based View of the Firm
By
Steven Toms
Correspondence:Steve TomsProfessor of Accounting and Business HistoryNottingham University Business SchoolJubilee CampusNottingham NG8 1BBTel: 0115 951 5276Fax: 0115-956-6667Email: [email protected]
Acknowledgements: I would like to thank participants at a seminars held at theAssociation of Business Historians Conference, University of Reading and theEuropean Critical Accounting Studies Conference University of Leicester ManagementCentre, 2002 for helpful comments on earlier versions of this paper.
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Accounting for Entrepreneurship: A Knowledge-Based View of the Firm
Abstract
The paper articulates a knowledge-based balance sheet with reference to the location
of knowledge and the structure of accountability. This framework shows that there are
several generic strategies open to entrepreneurs. Although always constrained by
general framework of the capitalist mentality, historically variant structures of
accountability explain changes in the more detailed patterns of entrepreneurial
behaviour. The paper briefly reviews the main areas of entrepreneurial theory and
takes an integrative and analytical view of entrepreneurship, offering the possibility of
reconciling divergent interpretations of entrepreneurial behaviour, according to the
location of knowledge and other assets and the structure of accountability. From this it
goes on to develop and test a typology of entrepreneurship.
Rather than accept the argument that the 'knowledge based economy' is a new
phenomenon, based on recent technical discoveries, the paper takes the view that
knowledge distribution and accountability structures are perennial features in a
capitalist economy. The main empirical focus of the paper is therefore the process of
industrialisation, exemplified by the experiences of British entrepreneurs in the latter
part of the eighteenth and the nineteenth centuries. These examples illustrate how
entrepreneurs were able to use knowledge to appropriate and accumulate wealth, both
fraudulently and legally, as mediated by historically variant structures of
accountability.
The paper deals first with the generic business strategies of entrepreneurs and
examples of opportunistic and fraudulent behaviour, then goes on to consider their
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attitudes towards networking and then their political lobbying stance. Conclusions
argue that the analytical framework developed in the paper is well supported by
historical evidence, showing that accounting theory can deepen our understanding of
significant events, such as the British Industrial Revolution and offer useful
commentary on other social phenomenon, such as the role of entrepreneurs in
'dynamic' economies.
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Accounting for Entrepreneurship: A Knowledge-Based View of the Firm
Introduction
The vast majority of the literature on accountability, governance and corporate
finance, especially where derivative of principal agent and transaction cost theory has
been concerned primarily to explain managerial behaviour, in terms of monitoring,
incentives and contracts. This approach has also dominated much of the accounting
and finance literature (Watts and Zimmerman, 1986), has been the focus of critical
analysis (for example Tinker et al 1982), including alternative models of
accountability (Grey, Owen and Maunders, 1991). The starting point for conventional
and critical analysis has been the separation of ownership and control between
shareholders and managers, rather than managers and other providers of finance,
including working capital suppliers. Also relatively little attention in the accounting
literature has been paid to entrepreneurs as individuals or to entrepreneurship as a
functional set of responsibilities. This is partly because the standard dichotomy
implies an arbitrary assignment to either the principal or agent functions or
combination of the two. The reasons also reflect the historical, but contingent
dominance of 'Berle and Means' style companies in the US and UK economies during
the 20th century. Powerful managers and weak shareholders suggest that the
entrepreneurial function is subsumed within a managerial bureaucracy (Pollard, 1962,
p.2). A final and very important problem is that if the focus of accountability is
shifted from managers to entrepreneurs there is an apparent endogeneity problem
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since the creation of (or escape from) accountability structures might be considered
part of the function of entrepreneurship. As Hopwood (1987, p.213) suggests,
organisational accounts are not merely a technical reflection of pre-given economic
imperatives but are actively constructed to create economic visibility, as a powerful
means for positively enabling the governance and economic control of the
organisation. The purpose of this paper is therefore to analyse accountability and
entrepreneurship concurrently and dynamically with reference to historical evidence
from the British industrial revolution.
The paper begins by explaining the sources of entrepreneurial knowledge and
its appropriation using a simple model. It is then tested with reference to the mainly
nineteenth century examples from the British economy during the process of
industrialisation. It deals first with the generic business strategies of entrepreneurs,
including a typology of fraudulent activity in the absence of regulation. It then goes
on to consider their attitudes towards networking and then their political lobbying
stance. The propositions from the model are illustrated with reference to the business
strategies of British entrepreneurs in each of these areas. The paper ends with a
discussion and conclusions.
Entrepreneurship, Knowledge Assets and Accountability
Entrepreneurs are often viewed as an important determinant of economic success.
Recently they have been lauded as the source of creativity in dynamic knowledge
driven economies. Attribution of virtue in entrepreneurs, such as 'creativity', and
different and implicitly superior cognitive processes, is a common starting point for
many researchers (for example Alvarez and Busenitz, 2001, Gavetti and Leventhal,
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2000, McClelland, 1961, Zahra, 1996). Other defenders of entrepreneurs have pointed
to their ability to 'optimise within constraints' (McCloskey and Sandberg, 1972).1 This
is essentially a 'managerialist' view in which entrepreneurs perform managerial tasks,
competently or otherwise (Lazonick, 1991). Schumpeterian entrepreneurs engage in
creative destruction and such like activities to remove constraints upon business
activity. (Schumpeter, 1939, Lazonick, 1991). An important necessary condition for
such activities is access to external capital resources, a requirement that is accentuated
where there are significant exit barriers associated with existing activities. Exit and
subsequent development of new ventures may give rise to habitual, serial or portfolio
patterns of entrepreneurship. The Austrian view suggests that heterogeneity of beliefs
about asset values give rise to both entrepreneurial opportunity and the discovery of
market prices, implying alert entrepreneurs profit from price differences (Casson,
1982, Kirzner, 1979, 1989). Such entrepreneurs for example might provide
information in a price system. Entrepreneurs may also appear as 'rentiers' able to
defend monopoly and privilege through effective lobbying (Green, 1988). The current
paper takes an integrative and analytical view of entrepreneurship, but one offering
the possibility of reconciling Schumpeterian, Austrian and other views. Such an
approach is also consistent with the view that all economic agents within capitalism,
including entrepreneurs follow a similar rational approach to decision taking (Weber,
1928, p.334) and adopt a similar calculative mentality (Bryer, 2000a, 2000b).
Entrepreneurial strategies are the eclectic pursuit of surplus value and maximum
return on capital employed (Bryer, 2002). Combining these elements, the discussion
below sets out a model of entrepreneurship based on an analysis of the origins of
valuable knowledge and the basis of its appropriation.
1 Scale is one factor that might explain the subsumption of modern entrepreneurship
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The model takes a rationalist view of entrepreneurship. If the outcome of
entrepreneurial activity is the generation of superior returns (Cannon, 1991, p.17),
then entrepreneurial activity necessarily comprises identifying sources of economic
rent. This may or may not involve additional risk. Risk seeking behaviour is often
irrational and in any case if entrepreneurial opportunity is based on superior
knowledge it is likely that the circumstances allow risk reduction or avoidance. This
view is consistent with known theories of value, but inconsistent with views that
attribute systematic positive return outcomes and hence value to apparently the
superior human attributes possessed by entrepreneurial types (for examples of the
latter, see McClelland, 1961, Ronstadt, 1984).
The entrepreneurs of industrial Britain have been subject to such stereotyping,
as often derogatory as complimentary. These hard nosed penny pinching pragmatists
were at the same time the dynamic engine of the industrial revolution and through
their attachment to tradition and old-fashioned business attitudes, its ultimate break
lever (Aldcroft, 1964, Landes, 1969, McCloskey and Sandberg, 1972). These views
have influenced the historiography of the industrial revolution and its aftermath,
particularly in terms of the apparently developmental and then regressive role played
by entrepreneurs during industrialisation and maturity. Whilst the primary purpose
here is to develop and test a model of entrepreneurial behaviour rather than reinterpret
the historiography of the nineteenth century British industry, some reconciliation of
these stereotypes is nonetheless a logical outcome of this investigation.
The starting point for the analytical model is the two sources of business secret
or types of valuable knowledge accessible by entrepreneurs. These are organisation-
specific sources that might create idiosyncratic or 'tacit' knowledge (ISK) (Castanias
within this managerialist view. Pollard, 1962, p.2).
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and Helfat, 1991).2 Such knowledge might be developed through organisational
learning at the general level.3 Specific examples might include identification of more
than one use for non-fungible assets, including human capital assets (Teece, 1980).
Internal knowledge, where valuable, has the characteristic of being difficult to imitate,
reflecting the heterogeneous nature of assets advocated in the resource-based theory
of the firm (Alvarez and Busenitz, 2001). An alternative source of knowledge comes
from outside the organisation. These are external pools of knowledge, (Marshall,
1890, Kamien et al, 1992), which usually have a public good element such as local
pools of experience and skilled labour.4 This is defined as public good knowledge,
PGK. If the knowledge is valuable, there are two ways in which the value can be
appropriated: as private rent (perquisites, PQ) or as external financial stakeholder
return (profit, Π) plus monitoring cost (MC). Two types of knowledge and two types
of appropriation provide us with an alternative 'knowledge' balance sheet'. This might
be represented as:
PGK + ISK = PQ + MC + ΠΠ (1)
Or:
2 This approach follows the intuition of the resource-based view of the firm andsubsequent elaboration. See for example, Penrose, 1959, Teece, 1980. Such resourcesmight include specialised production facilities, trade secrets and engineeringexperience (Teece et al, 1997).
3 For current purposes, organisational learning is defined as 'encoding inferences fromhistory into routines that guide behaviour'.
4 These can include linkages with higher education research bases and explain thesuccess of some industries, for example the German synthetic dye industry (SeeMurman, 2000).
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PGK + ISK - PQ - MC = ΠΠ (2)
In the limiting case where all knowledge is ISK, production efficiency is achieved
through internalisation of economies of scale and scope. From a financial market
perspective all risk is firm specific, Although there are theoretical gains to investor
diversification where risk is specific, the opportunities for diversification may be
undermined by monopolistic control of product markets.5 Abnormal profits are
generated and significant rents are available for appropriation between managerial and
ownership groups, split according to the effectiveness of monitoring arrangements.
Conversely, if all knowledge is PGK, allocative efficiency is achieved through
specialisation. From a financial market perspective all risk is systematic and again,
although for a different reason, there are no gains to investor diversification under
such circumstances. Profits are normal and accrue to solely to owners.
An important dimension to the equations is the extent to which knowledge is
appropriated privately by owner managers (minus supervision costs) or publicly by
external providers of finance (minus monitoring costs). The split depends on the
socialisation of capital. Systems of accountability depend on the exercise of social
power within and outside the organisation (Hopwood, 1987). The process of
socialisation,6 or pooling of money reserves, whether through banks or capital
5 Financial theory contrasts systematic risk, where returns on an individual securityfluctuate in line with general market fluctuations, with specific risk, wherefluctuations in an individual security's return reflect firm-specific events.Diversification by portfolio investors only eliminates specific risk. For a review, seeBodie, et al, 1999).
6 Social capital refers to the accumulated wealth attributable to capitalist production.Such capital is individual in the sense that it is represented by monetary claims of
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markets (Campbell, 1988), that leads to different forms of business organisation,
governance and accounting. On the one hand social capital represented by the pooled
capital of sophisticated investors, demands accurate financial information through the
medium of modern financial reporting (Bryer, 1993). On the other private capital has
no such responsibility to outside investors. As a result monitoring costs are avoided
and the owner/managers appropriate all profits. Such a perspective also accords with
the Political Economy Contingency Theory of Capital Accumulation (PECTA), which
suggests that corporate profitability is a product of institutional arrangements well as
internal arrangements (Zey and Swenson, 2001, p.464). These include capitalist
relations of production and the political-legal relations of the state (Gordon et al 1982,
Bowles, Gordon, and Weiskopf, 1983, Kotz, et al 1994, Zey and Camp, 1996, Zey
and Swenson, 2001). In other words capital dependency on outside investors
including governments is an important determinant of accountability and
organisational behaviour. 7
Where knowledge is internalised within the organisation, both socialised and
private capital share the problems of monitoring and supervision. This is because the
valorisation of knowledge, such as the application and commercialisation of a new
technique will involve some degree of delegation. As suggested above, this situation
is often exploited through scale economies, which in turn suggest labour
specialisation, and which also necessarily imply supervision. In contrast, the
individuals, but collective in the sense that the claim is on the pooled capital, not on aspecific asset and freely transferable between members (Bryer, 1993, 1997, 2000a).
7 PECTA or capital dependency is also viewed as a special case of resourcedependency (Zey and Swenson, 2001, Prechel, 2000).
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merchanting function, along the second row of the matrix, typically involves trading
claims where the number of staff is relatively small (Pollard, 1962, p.9).
This analysis can be used to suggest a typology of entrepreneurship, set out in
figure 1. Each quadrant is explained in turn, with reference to historical examples.
The columns of the matrix suggest different modes of accountability, depending on
the degree of dependency on outside capital. The rows suggest value creation through
the control of labour (typically manufacturing capital) on the first and through
exploitation of price differences on the second (typically merchant capital). These
categories are related dynamically through the process of economic growth. As
technological progress builds on previous knowledge and discovery, so the
internalised base of knowledge and publicly located knowledge bases increase.
Within the firm this increases the scope of managerial activity and layers of
bureaucracy, deskilling from the bottom of the organisation upwards as the impact of
increased specialisation develops. However, managerial and entrepreneurial rents are
only available to the extent that knowledge remains located in the private domain of
the firm, whilst technical progress and innovation demands increased utilisation of
generic skills supplied in the public domain through education etc. At the same time,
increased financial resources are required to secure commercial exploitation, likely to
Figure 1: A Knowledge Based typology of Entrepreneurship
ACCOUNTABILITY
High Low
Internal 1. ISK = Π[Venturers/co-operators]
2. ISK = MR[Intrapreneurs]
Location ofknowledge
External 3. PGK = Π[Arbitrageurs]
4. PGK = MR[Serialentrepreneurs]
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increase the involvement and scrutiny of socialised capital. However, entrepreneurial
or managerial rents can only be privately appropriated to the extent that such scrutiny
can be avoided. Hence, in the Marxian sense the development of productive forces
and their ownership are in contradiction. Historical development proceeds through the
dialectical resolution of these objective and subjective factors. In terms of the matrix,
precise location reflects the relative strength of these historic forces.
Historical examples from the British Industrial Revolution
The above framework has suggested four generic modes of entrepreneurship.8 In this
section, each is discussed in turn with reference to examples from the British
Industrial Revolution. The framework has also suggested possible patterns of
fraudulent or manipulative behaviour, which had important impacts on the
development of the British economy during this period and examples of these are also
used to illustrate the cases.
In Figure 1, in quadrant 1, reliance on internalised, potentially patented
knowledge means that this group most closely resembles the rentier model of
entrepreneurship. Socialised capital, implying co-operation amongst owners or
venturers relies on pooled capital to exploit shared knowledge and to secure equal
returns for the capital advanced (Bryer, 2000a, 2000b). The East India Company is an
early example, later followed by canals, railways and other infrastructure projects.
These required significant accumulations of engineering and other technical
8 This is not the first paper to suggest a typology of entrepreneurs. For a contrastingexample see Casson, 1982).
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knowledge and ultimately large managerial staffs, which in turn demanded significant
mobilisation of social capital.
In quadrant 2, the mode of entrepreneurial operation is 'intrapreneurship',
including cliques, family and managerial groups. They operate as secretive cliques
shunning dependence upon and accountability to external resource providers. Desire
for secrecy means that they economise on resources and shun growth in favour of
control, so this group most closely resembles the optimising model of
entrepreneurship. Their internal knowledge of the value chain is reinforced by the
generic strategy of vertical integration. Between 1815 and 1841 the medium sized
firm emerged as the optimum business unit in Manchester (Lloyd-Jones and LeRoux,
1980). This was based on vertical integration between spinning and weaving and
more intensive use of capital and human resources. Growth beyond medium size was
constrained by uncertainty, competition for orders and lack of managerial talent
(Lloyd-Jones and Lewis, 1980, pp.200-208). So new entrants increased output and
reduced prices (Lloyd-Jones and LeRoux, 1982) and entrepreneurs ignored growth
opportunities presented by further scale economies (Gatrell, 1977). Vertical
ownership rather than process integration was used to control of the value chain.
Hence prosperous provincial manufacturers such as Peel and Horrocks and Fielden
established warehouse businesses in Manchester goods (Chapman, 1979, p.219,
Chapman, 1996).9 One reason for their success was that combined firms such as
Fielden were able to transfer resources between merchanting and manufacturing
9 In Manchester in 1815, 42% of warehouse units were controlled by combinedmanufacturer/merchants (Lloyd-Jones and Lewis, 1980, p.57), and despite subsequentrevolutions in trade (Chapman, 1977, p.13) remained entrenched until mid century(PP Royal Commission on the Depression in Trade, Third Report 1886, pp.15, 21 (evSir J.C. Lee)
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utilising partner's capital accounts (Chapman, 1996). These mechanisms illustrate
how this entrepreneurial group sought maintained private control over disparate
business empires.
In quadrant 3, the mode of entrepreneurial operation is arbitrage, exploiting
differences in publicly available knowledge, and using published prices to exploit
disequilibria. Of the four types, these entrepreneurs most closely respond to the
Austrian model. The play an important role in capital market making and in the
development of futures markets, for example the Liverpool merchants and brokers
trading in cotton futures (Dumbell, 1927, Hughes, 1960, Chapman, 1996b).10 Other
examples included exporters on commission and commission agents resident abroad.
Such firms encouraged customers into British markets, providing them with finance
for their purchases. Many of these new entrants began with small capital, but took
advantage of plentiful and cheap capital available in Britain in the 1830s from
competing accepting houses (Chapman, 1977, pp.14, 24). These provided export
finance provided by discounting facilities creating opportunities for those prepared to
take the risks of international trade away from industrialists (Chapman, 1984, Roberts,
1993).11 According to some (Casson, 1993, Pollard, 1972), this amounted to a 'web of
credit' underpinned by a high-trust culture that controlled access and sustained the
flow of working capital.
In quadrant 4, the mode of entrepreneurial operation is serial entrepreneurship.
These entrepreneurs accumulate at the individual rather than firm level, and resemble
10 See also, F. Engels, footnote to Marx, Capital III, p.409. Although not referred to as'entrepreneurs', market participants with asymmetric access to information are anecessary condition for the functioning of capital markets (Grossman and Stiglitz,1980).
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venture capitalists by ploughing previously accumulated savings from previous
activities into new, often unrelated, business ventures. Withdrawal and redeployment
of capital is an attribute that makes this group most closely resemble Schumpeterian
entrepreneurs. It is this entrepreneurial group that most resembles those identified by
Pollard (1962), who were concerned to avoid the managerial costs associated with
controlling and supervising labour. Merchants such as Gott used capital accumulated
from merchanting to participate vicariously in manufacturing by hiring technical
expertise (Pollard, 1962, p.30). This accounted for the survival of out-working and
subcontracting in industries such as textiles. In any case fixed capital requirements
were low, for example in the Lancashire cotton sector before 1830, allowing such
capitalists to make serial investments in unrelated businesses, thereby perpetuating
systems of localised, personal and informal systems of finance (Wilson, 1995, p.48).
Warehouse-based businesses also avoided narrow specialisation and diversified their
activities. Owen Owens did so in order to keep capital in constantly employed (Clapp,
1965, p.23, Lloyd-Jones and Lewis, 1988, p.114). Manchester merchant
manufacturers like Owens used the domestic system to impose short credit cycles and
rapid exit in the event of a downturn in trade (Clapp, 1965, p.20). Owens and his
successor John Owens constantly exited unprofitable markets and used the capital to
seek out new opportunities. These included the equity investment in the
manufacturing partnership of Samuel Faulkner and Company. More striking was the
diversification in products that accompanied switches from one market to another. For
example the switch from the North American export market in the 1820s to South
11 By 1833, only around 2% of firms in the cotton industry were shipping abroad ontheir own account Select Committee on Manufactures (PP 1833, VI), pp.314, 317 and319.
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America in the 1830s.12 Activities in the latter included a joint venture with Fielden
Brothers and Co. and William Whittaker and Co. to import goods from Buenos Aires
in 1840.13 By the 1840s Owens and others diverted much of their activity and capital
to investments through loans to other businesses and in railway shares.14 Thus
although these firms were nominally integrated merchant/manufacturers, they also to
some degree resembled venture capitalist organisations. Whilst they diversified their
investments, it was not on the basis of a portfolio approach of simultaneous
diversification into unrelated activities. Owens in particular was a serial investor, with
significant commitment to each of the chosen successive fields. For these firms, the
distinction between fixed and working capital was relatively meaningless, since all the
capital was recycled on a regular basis. Working capital provided 'massed reserves'
(Florence, 1933, p.17) against risks of trade. 15 At the aggregate level, increased fixed
capital requirements in spinning and manufacturing caused cotton magnates to move
into joint stock banking in the 1840s, partly because external financial support was
12 F. Baker, Owen Owens and Son Archive, 1805-1874 (Unpublished guide to thearchive, John Rylands Library, University of Manchester).
13 Owen Owens Archive, John Rylands Library, OWN/3/2/4/11.
14 For evidence on Owens, see Baker, Owen Owens and Son Archive and details ofOwen's portfolio of railway investments in the 1840s, John Rylands Library, LedgerOWN/1/1/1/4. Another firm that used its accumulated capital from manufacturing todiversify into loans beyond the core activity was John Heywood and Company(Lloyd-Jones and Lewis, 1988, p.118). Fielden Brothers also diverted a significantproportion of their capital into railway investments in the 1840s (Chapman, 1996,p.17).
15 Profits varied enormously from market to market, but an average profit of 3-5% oncapital 'over and above interest' was considered an adequate risk premium.Parliamentary Papers, Select Committee on Handloom Weavers' Petitions, 1835,p.329. ev. W. Graham.
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otherwise particularly important during the ebb of the trade cycle (Jones, 1978,
p.105).
Some authors have suggested that there were benefits associated with these
highly individualised patterns of entrepreneurship (Wilson, 1995, p.53), particularly
as suggested by quadrants, 2, 3 and 4. However this is disputed. For example, others
have argued that the financial institutions 'failed' British business (Gerschenkron,
1966). It has also been suggested that inadequate access to working capital finance
stunted the growth of some industries, for example cotton (Chapman, 1979). Although
these are important issues in the historiography, the model in Figure 1 has
entrepreneurship rather than economic growth as its dependent variable. The above
review is limited in the historical sense, but nonetheless intended to be sufficient as an
illustration of the Figure 1 typology.
Entrepreneurship, opportunistic behaviour and fraud
Rather than regard one particular mode of entrepreneurship as a success or failure an
alternative perspective is to suggest that there are opportunities for fraud or rent
seeking whose character varies depending on the parameters of the model. If
entrepreneurs are self-seeking, as might be commonly expected, they might also be
expected to use guile in the process. In other words entrepreneurship might be
analysed according to Williamson's (1985) definition of opportunistic behaviour.
Figure 2 suggests the sources of surplus, excess or fraudulent profits and offers
examples of different types of opportunistic behaviour and fraudulent activity.
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Figure 2: Entrepreneurship, Opportunistic Behaviour and Fraud
AccountabilityHigh Low
ISK 1.Extraction ofsurplus.AsymmetricinformationExamples:FraudulentprospectusesRailway swindles
2.Extraction ofsurplusExamples:Health and safetyneglectChild labourscandals
Location ofknowledge
PGK 3.Extraction of rentAsymmetricinformationExamples:South Sea BubbleArbitrage
4.Extraction of rentExamples:Veil ofincorporationfraudsMoney launderingCotton swindles &corners
Quadrant 2, being a special case, is dealt with first. Where capital is unsocialised there
is no opportunity for entrepreneurs to defraud outside equity investors. Due to the
internalisation of resources and knowledge and absence of external scrutiny, this leads
to scandals rather than fraud, for example of poor health and safety and exploitation
of female and child labourers. Profits therefore depend on the extraction of surplus
value through the control of labour and of the working day. It was over these issues
that moral battles between philanthropic and rapacious entrepreneurs were fought out.
Robert Peel's claim that he delegated to overseers who in turn hired children and
perhaps exploited them, but that this was none of his own responsibility (Pollard,
1962, p.270), illustrates one example of how accountability within the labour process
18
was conveniently covered up. In this case by the entrepreneur denying knowledge and
control over what was happening in his own factories. Whilst labour exploitation is
not ruled out in the other 3 quadrants, these also present opportunities to earn rents
through swindles and frauds or simply by accessing information asymmetries.
In the left-hand column of figure 2, there are opportunities for entrepreneurs to
act fraudulently, exploiting either PGK or ISK. In the former case, represented by
quadrant 4, information asymmetries arise as a result of imperfect capital markets. For
example in the South Sea fraud capital was initially raised from credulous investors
on the promise and nothing more of untold riches from the spice trade. This was not
based on inside knowledge, merely a believable lie and ignorance of geography (Neal,
2000a, 2000b). Cotton swindles (Marx, 1984, p.411) provide further examples of
systematic fraud arising from issue of additional bills on the same goods leaving
businesses vulnerable to sudden rises in discount rates during commercial crises.
Where knowledge is internal, as in quadrant 1, there is a moral hazard problem
that can be exploited by managers to mislead socialised capital. If knowledge is
external, information asymmetries arise from the distinction between informed and
naïve investors and 'swindles' are more likely when monitoring and transaction costs
or the costs of becoming informed are high.16 These costs are dependent on the
socialisation of capital and the effectiveness of the accountability structure.
Manager/entrepreneurs with inside technical knowledge are able to fool uninformed
outside investors. Railway flotations in the nineteenth century, characterised by some
as 'swindles' and satirised by Trollope in The Way We Live Now,17 and more recently
16 This logic is derivative of the relationships suggested by Grossman and Stiglitz,(1980).
17 Railway 'swindles' are referred to in Marx (1984, p.410), and analysed in moredetail in Bryer, R. (1991). For a discussion of the impact of railway flotations and
19
dot-com companies, illustrate the importance and potential ineffectiveness of
accountability structures and supporting regulatory institutions from the perspective
of the naive investor. In the cotton industry, operators such as John Bunting exploited
new flotations in similar fashion, ultimately undermining the collective accountability
of the co-operative system (Toms, 2002).
Finally in quadrant 4 the 'veil of incorporation' style fraud occurs where an
entrepreneur uses a business to establish a credit network, but controls the equity of
the firm, then withdraws capital thereby defrauding the creditors.18 In this case capital
is unsocialised, there is no intention of attracting long-term investment in the internal
knowledge base and the entrepreneur exploits external contacts and networks to
perpetuate the fraud. Other examples include fraudulent issuing of bills of exchange.
Merchants created a credit bubble in the 1840s using this mechanism (Marx, 1984,
p.409). These operations typically used unsocialised privately held merchant capital
and exploited existing vertical and network trading structures. The use of Commission
agents for the first time in the 1840s facilitated this activity. Before then
manufacturers and finishers such as calico printers bought and sold their own cloth
(Howe, 1984. p.16). Further risk arose from political uncertainty in overseas markets
and bad debts arising from certain customers or markets. Money laundering is another
type of fraud to be found within the parameters of network based external knowledge
and secrecy of privately held capital, particularly through poorly regulated banking
systems (Strange, 1998, ch.7). A final example is the use of private capital such as a
hedge fund to engage in market manipulation or to corner a market. Due to the
interventions of such financial syndicates, cotton ‘corners’ became regular
business behaviour in general on the Victorian novel, see Alborn (1995).
18 Salomon v. A. Salomon & Co. Ltd (1897)
20
occurrences affecting the Liverpool and New York markets from the early 1870s
onwards (Oldham Standard, 24th August 1889).
All of this suggests a calculative rational view of entrepreneurs, in which they
get away with what they can or are allowed to. It stands in contrast to the many
famous examples of ethical enlightened entrepreneurs of this period. However, the
purpose is to explain aggregate behaviour and individual entrepreneurs might be
expected to fall along some continuum of good and evil. Even in the case of
apparently philanthropic entrepreneurs such as John Bright and John Fielden, the
model goes some way towards explaining their attitudes towards the political
regulation (or lack of) of business activity. This is dealt with below. First it is
necessary to extend the model to consider dynamic and network elements.
Entrepreneurship and Network Characteristics
Based on the above relationships, entrepreneurial network participation reflects the
location of knowledge and other resources and by how the resources are accessed. A
resource-based view of the firm can be extended to the context of a resource-based
view of the cluster as a whole or system. Where resources are ISK and internal, this is
likely to promote internalisation with a hierarchic structure. Similarly, where
knowledge is PGK, small-scale and specialised firms are promoted and these will
draw on a narrow resource base and will draw on market inputs for non-specialised
functions. Resource sharing and specialisation at individual firm level promotes
21
heterarchic network structures, with high density,19 whereas greater internalisation by
a single firm promotes network with greater centrality.20
If entrepreneurs organise networks where there is previously a pure market,
then market processes are substituted along heterarchic lines. Examples might include
inter-firm arrangements to control supply and price, particularly where firms with
narrow resource bases lack the market power to do so singly. Similarly if there is
hierarchy, network development by entrepreneurs substitutes for the original internal
relationships (Fruin, 1998, p.9). Examples might include outsourcing to associated
companies, 'subsidiarisation',21 enforcement of supply via dedicated contracts, and
horizontal amalgamation of semi-independent firms within a federal combine
structure.
Transparency and opacity are a function of the degree of capital dependency
as defined earlier by the PECTA model, which create reciprocal agency, monitoring
and transaction costs. Opaque networks are unaccountable to external stakeholders
and more likely to be self sufficient in resource terms. Transparent networks on the
other hand demonstrate accountability and are more likely to be capital resource
dependent. Thus on the horizontal axis, self-sufficient and resource dependent
networks correspond to opaque and transparent accountability. Transparent
governance and accountability is more likely to be socially constructed whereas self-
19 Density refers to the actual number of ties as a proportion of all the possible tieswithin a network structure. As density increases norms are diffused and behaviourbecomes more similar. For a discussion see, Meyer and Rowan (1977).
20 Centrality refers to the prominence of an individual actor within the networkstructure. For a discussion see, Brass and Burckhardt (1993).
21 Subidiarisation refers to the transformation of tightly controlled divisions into moreautonomous subsidiaries in large US corporations in the 1980s and 1990s. For adetailed definition see Zey, 1999.
22
sufficiency is more likely to be naturally occurring. In a longitudinal framework,
economic action is 'embedded' (Granovetter, 1985) by ex ante resource distribution
and accountability structures. It should be noted that this discussion implies two levels
of accountability. The main concern here is the degree of accountability by the
network to outside stakeholders. However, there is also the question of intra-network
accountability. This will depend on network density and centrality, as defined earlier,
so that dense networks will tend to diffuse norms of accountability within the
network, whereas centrality may limit the degree of information sharing.
Another important determinant of network characteristics is the rate of capital
accumulation and growth. This in itself is a function of the rate of technological
change, which establishes the available internal and external economies of scale
within the industry, district or economy. Self-sufficient networks are almost by
definition unconcerned with growth and may be appropriate to low-growth industries
or to support rationalisation, patent based monopoly production, etc. Conversely in
high growth industries, firms and networks require funds for production facilities,
advertising, research and development that can only be obtained externally. In general
past growth influences the current resource base whilst future growth impacts on the
degree of resource dependence. Combining these influences, this suggests the
following network typology corresponding to the matrix quadrants in figure 3:
1. Hierarchy substituting, high external resource dependency (resource
dependent) networks. These are most suitable for co-operator style
entrepreneurs, operating in joint stock and managerial capitalism underpinned
by high past growth and with high future growth prospects.
23
2. Market substituting, high external resource dependency (resource dependent)
networks. These are most suitable for arbitrageur style entrepreneurs,
operating in joint stock and alliance capitalism underpinned by low past
growth and with high future growth prospects.
3. Hierarchy substituting, low external resource dependency (self-sufficient)
networks. These are most suitable for cliques, proprietors and family groups
style entrepreneurs, operating in managerial and proprietary capitalism
underpinned by high past growth and with low future growth prospects.
4. Market substituting, low external resource dependency (self-sufficient)
networks. These are most suitable for serial entrepreneurs style entrepreneurs,
operating in proprietary and alliance capitalism underpinned by low past
growth and with low future growth prospects.
24
25
26
27
28
Figure 3: A Typology of Network Structure
At the earliest stages of the industrial revolution, entrepreneurs created networks
primarily to substitute market processes. The domestic putting out system allowed
entrepreneurs to avoid supervisory costs and the requirement to assimilate technical
knowledge personally whilst sharing risks with subcontractors (Pollard, 1962, p.38).
Such credit-based networks were significant in GDP terms and assisted
industrialisation by facilitating distribution at competitive prices (Brown, 2000).
Strategic Context: Degree of
Accountability
Transparent Opaque
Extensive Quadrant 1
Hierarchy
substituting, high
capital dependency
networks
Quadrant 3
Hierarchy
substituting, low
capital
dependency
networks
Strategic Content:
Organisational
Resource Base
Narrow Quadrant 2
Market
substituting, high
capital dependency
networks
Quadrant 4
Market
substituting, low
capital
dependency
networks
29
These arrangements as in the post bellum American Deep South often empowered the
credit brokers at the expense of poor sharecroppers (Jacobson and Smith, 2001). Such
arrangements were not necessarily superseded by further industrialisation. In the road
haulage industry of the 1930s sub-contracting was promoted by Clearing houses,
established to allocate loads on return journeys, were able to dictate the profits of sub-
contracting hauliers by exploiting informational asymmetries and controlling entry
and exit through HP agreements and service contracts (Scott and Reid, 2000).
In certain cases as the industrial revolution progressed, networks substituted
for hierarchies, partly reflecting a refusal by entrepreneurs to commit themselves to
the labour management and accountancy skills required for the management of multi-
unit operations (Pollard, 1962). In charcoal and iron and the early coke blast furnace
industries, interlocking partnerships secured control of the value chain through mutual
co-operation and delegation of managerial responsibilities. (Pollard, 1962, p. 40).
These partnerships promoted self-sufficiency within the network. Hence intra-
network accountability was strong but low dependence on outside resource provision
and control of the value chain meant these networks could avoid accountability to
wider society. A common intra network enforcement mechanism is the trade
association, which has often served to establish rules of business conduct and the
regulation of competition through governance practice (Scranton, 1998). Such
organisations together with the other network attributes described above are also
important as a basis for political activity and lobbying.
Lobbying strategies and political economy
30
The earlier analysis suggests a further taxonomy of entrepreneurial action, this time in
relation to political lobbying. This is summarised in figure 4.
Figure 4: Political Economy and Lobbying Strategies
Capital Dependence
High Low
Internal High regulationHigh intervention
Low regulationHigh intervention
Scale Economies
External High regulationLow intervention
Low regulationLow intervention
31
Differential rates of capital accumulation create divisions among major business
sectors (Berg and Zald, 1978). The strongest class segments are those where
economic concentration is highest and this results in a low level of state autonomy,
(Baran and Sweezy, 1966, Poulantzas, 1978) and high levels of resource sharing and
inter-dependence between industry and state, or capital dependence. PECTA suggests
that political institutional arrangements become more aligned during periods of
prosperity, but break down in periods of declining profitability (Gordon et al 1982).
Concentrated class segments are therefore more likely to lobby for state intervention
and exploit such interventions to their advantage. Conversely they may experience
intervention as a result of their dominant position, for example industries such as steel
and railways whose internal economies form the basis of external economies for other
industries. These industries are able to mobilise influence and resources in favour of
production efficiency. Where economies of scale are more difficult to internalise and
knowledge is more typically PGK on the bottom row of the matrix in figure 4,
markets are more likely to be allocatively efficient and firms face lower risk of
intervention. At the same time, knowledge and resource dispersal reduces the
effectiveness of lobbying for political intervention by these groups. Finally self-
sufficiency and capital resource dependence may reflect the politics of regulation and
ideology (Davis et al, 1994). Competition policy, company law and rules governing
financial institutions are the obvious examples (Fligstein, 1990). The absence or
presence of such rules influences the viability of secretive cartels and the level of
protection offered to external stakeholders. Meanwhile prevailing ideology may
influence the extent to which managers acquiesce to or promote accountability to
external stakeholders (Lazonick and O'Sullivan, 2000). Therefore in the columns of
32
figure 4, a high degree of capital dependency is likely to promote greater regulation,
thereby modifying accountability structures. In the left hand column future growth
and higher capital dependency promote greater accountability to external stakeholders
and create the scenario where governments usually need to regulate to protect external
investors, as in the Bubble Acts and company legislation. Meanwhile the pay-off for
less resource dependent entrepreneurial groups is greater freedom from regulation.
Returning to the entrepreneurial typology in figure 1, if the political lobbying
matrix is superimposed, this predicts the attitudes of different types of entrepreneur
towards lobbying and regulation. In quadrant 1 where entrepreneurship is takes the
form of managerialism under the rentier capitalism model, there is likely to be greater
emphasis on lobbying for resources and a high degree of regulatory intervention. This
is well illustrated by the railways. Railway entrepreneurs lobbied for recognition as
national institutions, thereby avoiding the requirement to pay local taxes and later for
state backing of loan finance. Legislation in 1844 and 1846 imposed rules for book-
keeping and private audit and proposals for state auditing in the Monteagle committee
of 1849 (Alborn, 1998, pp.177 and 186).
In quadrant 2, cotton merchants and brokers, primarily operating in Liverpool
exemplified Austrian style entrepreneurs. Their activities demanded standardisation of
cotton grades and they helped evolve rules, which resulted in the emergence of a
formalised exchange. From 1849 purchases of 'arrivals' became common and this
activity increased markedly in the late 1850s (Dumbell, 1927, Hughes, 1960, p.94).
After 1870 futures trading was formalised in New York forcing Liverpool to follow
suit (Chapman, 1996, p.87). These and similar groups looked to the Bank of England
for regulatory stability, particularly monetary policies that allowed sufficient liquidity
for discounting bills.
33
In quadrant 3, secretive entrepreneurial cliques will resist regulation but may
lobby for resources. Private capital owning Preston manufacturers and spinners
demonstrated these characteristics. In response to shortages of supply and the threat of
speculative buying in 1839 and to prohibitive raw material prices in 1847, cotton
manufacturers organised short time working (Hughes, 1960, Ward-Perkins, 1950,
p.84). They organised collectively in response to labour, as in the Preston strike of
1854 (Chapman, 1904, pp.209-239) as well as to brokers and importers and in 1857 in
response to the shortage of cotton supply at Liverpool.22 Preston entrepreneurs acted
on a joint resolution at a general meeting in response to these problems. This contrasts
with their oft repeated condemnation of the public companies and socialised capital of
Oldham (Toms, 2002) and with the refusal of Manchester merchants and
manufacturers to organise collectively as a political force.
Manchester school capitalism corresponds to quadrant 4 and the most 'laisser
faire' resistance to resource lobbying and collective action, other than to resist
regulation. In the 1846 crisis, although 'a binding combination' was sought (Hughes,
1960, p.92), that city's merchants refused to join organised lobbies from elsewhere in
the manufacturing regions for a repeal of the Bank Act, which many believed to be
responsible for the credit squeeze and the resulting crisis. Manchester capitalists
instead relied on secret networks on close network relationships with powerful
banking interests, reducing capital dependence. The established mainly Manchester
merchants and manufacturers were the winners according to the status quo. They had
knowledge of and access to markets via networks of agents, and financial contacts on
22 The Indian mutiny effectively 'suspended' the important Indian export market inJuly 1857 and also threatened the supply of Indian cotton The Times, 27 July, 1857.Contemporary estimates suggested stocks covered only eight weeks supply Callender(1858), The Times, 25 June 1857.
34
the boards of local joint stock banks (Jones, 1977, Jones, 1978, Rose, 2000, pp.72-4).
Cotton magnates also participated on the boards of these banks, enforcing a culture of
strict commercial secrecy and opaque accountability to customers, shareholders and
even in some cases to fellow directors (Jones, 1977, pp.106-109). Many had large
reserves of capital, itself an insurance policy against cyclical fluctuations, but which
was also represented as personal wealth diversified into land and other industries
(Howe, 1984, pp.28-43). The Manchester Chamber of Commerce, in a spirit of
independence, refused to join others, including Liverpool, in lobbying the government
to suspend the credit restrictions of the 1844 Banking Act. Opponents of limited
liability were not necessarily the enemies of accountability. Bright opposed the East
India Company partly because of its culture of secrecy but also because it diverted
resources to military expansion instead of infrastructural investment (Alborn, 1998,
pp.39-40).
Divergent behaviour in figure 4 is also a function of economic growth and
differential rates of accumulation. Manchester capitalists as discussed earlier
reinvested much of their surplus profits in railways, leading to overexposure to that
sector. This resulted in simplistic and misguided condemnation of railway speculators
for causing capital shortages in the 1840s.23 Speculation in railway shares only had a
detrimental effect on Manchester capitalists because they were serial and portfolio
investment had led them to invest surplus capital into an industry they did not
23 The real causes were political promises arising from the lobbying of others for entryinto the China market, which led to a wave of mill building by speculativeentrepreneurs in 1845. Parliamentary Papers, (Secret) Committee on CommercialDistress, 1848, viii, p.375, q.4950. .23 Crop failure in India was an importantcontributory factor (Farnie, 1979, p.106, Ollerenshaw, 1870, p.114). The Irish famineincreased food imports and caused an exodus of Bank of England gold reserves(Evans, 1969, p.55, Marx, 1986, Vol.3, p.408).
35
understand. Many were hit severely as a result. As one Manchester merchant put it: 'if
we had had a thousand tigers or leopards upon us, they could not have destroyed more
people than the railways have done.'24
As Manchester business interests learned these lessons, the formation of
industry associations became increasingly important as a response to threat and
uncertainty. In Manchester the initial impetus came only from the manufacturers, with
the spinners forced to follow suit later (Hughes, 1960, pp.91-92). However, as the
cotton industry encountered demand-constrained limits to expansion (Clark, 1992),
manufacturers increasingly recognised the risks of dependence on cotton from the
American South (Hughes, 1960, p.89). This was recognised following the cotton
shortages of the 1840s when Manchester cotton interests began to lobby for railway
investment in India as a basis for a cotton import trade (Alborn, 1998, p.39, Bearce,
1961, Silver, 1966). In February 1857, the Manchester Chamber of Commerce urged
the formation of a 'cotton league' to seek government aid in developing new sources
of supply (Hughes, 1960, p.90). In 1853 Manchester and Newcastle Commercial
associations petitioned parliament arguing that the East India Company should set
aside 10% of its revenues 'for the construction of trunk lines of railways ...and all
other engineering agencies required in a commercial and civilised country' (Alborn,
1998, p.39). A memorandum to the East India Company outlined proposals for
transport infrastructure to facilitate the growth and export of cotton from India (Watts,
1871, pp.119-23). In June 1857, the Cotton Supply association voted its articles of
faith as the extension of the growth of cotton in the dominions and all other accessible
countries (Redford, 1934, p.227). This was a long run response to an increasingly
limited supply relative to the growth of productive capacity (Hughes, 1960, p.93).
24 Parliamentary Papers, (Secret) Committee on Commercial Distress, 1848, viii,
36
The Manchester cotton interest was in general resistant to regulation but
sufficiently endowed with accumulated capital resources to be able to operate as a
powerful lobbying group. The helped the cotton industry as a whole overcome
demand based constraints on growth. Hence British foreign policy had an important
impact on the expansion of overseas markets. The opium war introduced the Chinese
to the benefits of free trade 'at the point of a bayonet' provoking a mill building boom
when Peel and Palmerston suggested that the trade might be expanded into this
market.25 A decade later the Crimean war provided a similar opportunity. The British
government provided Turkey with a loan of £5m, a substantial proportion of which
was used to import British cotton goods (Mann, 1860, T.25). Income generated by
army expenditures during the Indian mutiny fuelled an export boom to India in the
1858-1860 period (Hughes, 1960, p.96, The Times, 3rd Jan., 1859).
Whereas the powerful Manchester merchants had high ex ante capital
resources by 1850 and therefore low capital dependence, other less powerful groups
faced difficulties in accessing private capital and potentially high bankruptcy risk.
Relatively weaker lobbying groups, with limited access to internal economies of
scale, were less forceful in seeking political intervention, but tended to favour a
protective regulatory environment. The spinners and manufacturers of the south east
and north east of Lancashire had small capital requirements but lacked access to
secure trade finance. Their dependence on commission agents, acceptance houses and
banks increased capital costs and risk. This group that sought capital elsewhere by
advocating changes in the law on business regulation, thereby being able to exploit
the vehicle of limited liability. In the higher reaches of the Rossendale valley
p.371, q.4892. ev. Gardner
37
associations of artisans hoped that the joint stock form of organisation would provide
the means of escape from the thraldom of capital (Farnie, p.216). Their enthusiasm for
the corporate form was reinforced when they were refused credit by the established
institutions (Farnie, p.217). Robert Slaney MP, a campaigner for working-class
enterprise and limited liability called for a Royal Commission in 1852 (Bryer, 1997).
In contrast, much of the opposition to the proposals for limited liability put forward
by the Mercantile Laws Commission came from Northern metropolitan industrialists,
including the Liverpool and Manchester Chambers of Commerce (Jefferys, 1938,
p.41). Those that supported it were sensitive to the absence of outlets for the
profitable investments of accumulated capital (Jefferys, 1938).
Conclusions
The paper has taken a simple view of the purpose of the accountant's balance sheet -
to account for what is valuable (in this case knowledge) and the claims against that
value. It has extended this by showing that the categories on the knowledge balance
sheet correspond to the development of productive forces, their ownership and the
fact that these are in contradiction. This allows further analysis, via a typology of
entrepreneurship, as developed from a knowledge balance sheet and knowledge-based
view of the firm. The typology was used to explain business strategies, fraudulent
activities, network participation and political lobbying by entrepreneurs. In general
the empirical evidence supports the validity of the typology and the analytical
matrices suggested by it. These are summarised in figure 5.
25 Parliamentary Papers, (Secret) Committee on Commercial Distress, 1848, viii,
38
Figure 5: A Typology of Entrepreneurship
Quadrant 1'Rentier'
Quadrant 2'Austrian'
Quadrant 3'Optimiser'
Quadrant 4'Schumpeterian'
BusinessStrategy
Managerialism Arbitrage Intrapreneurship Serialentrepreneurship
'Opportunistic'behaviour
Creativeaccounting
Marketmanipulation
Exploitation Third partyfrauds
Networkingcharacteristics
Transparent,hierarchysubstitution
Transparent,marketsubstitution
Opaque,hierarchysubstitution
Opaque, marketsubstitution
Politicalstrategy
High regulationHighintervention
HighregulationLowintervention
Low regulationHigh intervention
Low regulationLow intervention
If this analytical view of entrepreneurship is accepted, it helps reconcile a
number of divergent views from the literature about what constitutes
entrepreneurship. It also follows that regulation to encourage entrepreneurship, for
example through changing governance arrangements (Short et al, 1999), will alter its
character rather than its aggregate level. Similarly it will alter the character of
fraudulent opportunity without necessarily altering the aggregate level of fraud. This
is not to suggest that regulation is undesirable and comment on this issue was beyond
the scope of the paper, except to say that regulation itself is partly a product of the
processes that also explain the characteristics of entrepreneurship.
The discussion also leads to some possible reinterpretation of the history of the
British Industrial Revolution. By the 1830s many firms depended on banking style
institutions for the finance of working capital. On the one hand this dependence
provided cotton spinners and manufacturers with access to the external economies of
scale required for selling their products in export markets. On the other, it limited
p.375, q.4950.
39
their freedom of entrepreneurial action. In the cotton industry and others this
dependence implicated many firms in the often-disastrous consequences of
intermittent commercial crises. Two strategies were adopted to secure independence
from commercial risk. On the one hand, entrepreneurs accumulated large capital
reserves and privately diversified their investments. They became venture capitalists
and supporters of the individualist 'Manchester School'. On the other hand, groups of
operatives and their representatives turned to the principles of co-operation, first by
establishing independent societies and later through advocacy of incorporation and
limited liability. Neither strategy was sufficient to control important linkages in the
value-chain as the industry became increasingly specialised. So although both
strategies provided the means to finance larger mills in the second half of the
nineteenth century, neither secured the desired independence from external financial
stakeholders and the vagaries of the trade cycle.
However, applying theory to history is full of pitfalls. Although the selection
of evidence might appear contrived to fit the model, that is partly a problem of
required brevity rather than historicism. Another problem in interpreting the evidence
is that entrepreneurs do not rigidly conform to one part of the typology through time.
Identifying longitudinal changes is the task of detailed historical enquiry, made easier
it is hoped through analysis of the matrix parameters outlined in this paper.
Whilst the use of historical examples has tended to confirm the validity of the
typology as an analytical tool and has stressed the importance of integrating the
location of knowledge with the structure of accountability, there is scope for
extension to more recent examples. The role of new knowledge based assets and their
mis-representation by accountants to defraud investors is one possible example.
Analysts of globalisation may also claim for example that centralisation of corporate
40
power means that executives are operating simultaneously in all four boxes. They
simultaneously raise enormous capital from world stock markets, and arbitrage them,
they promote and dominate alliances of other companies, and they locate secret
factories violating labour standards in the third world beyond the scrutiny of domestic
accountability. These global entrepreneurs may be a new phenomenon, but
nonetheless, as the historical examples show, there are perhaps some perennial truths
concerning particular aspects of entrepreneurial behaviour.
41
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